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January 24th 2016

Market Review

U.S. stocks ended the week with gains. The Dow Jones Industrial Average added 0.7 percent from the prior Friday’s close to finish at 16,093.51. The S&P 500 increased 1.4 percent for the week to end at 1,906.90. The Nasdaq gained 2.3 percent over the week to 4,591.18. For all three indexes, it was the first weekly gain in four weeks. Most key S&P sectors finished higher, led by technology, while financials ended in the red. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, declined to below 22.5.

Strategy Review

In last week’s comment we highlighted the fact that we expected to see further selling pressure as there were no major signs for an important bottom visible. In fact, after the bears had taken the S&P 500 down to 1,814.49 on an intraday basis on Wednesday (our suggested strong support/resistance level), stocks strongly bounced, closing therefore modestly higher for the rest of the week. Despite the fact that the market showed some solid gains, the improvements in the readings of our short-term oriented trend indicators have been developing moderately so far.

Short-Term Technical Condition

If we have a closer look at the Trend Trader Index, we can see that the S&P 500 was not even rudimentary able to break above the lower resistance line of this reliable indicator, which would be the first indication for a short-term trend reversal. Furthermore we can see that the envelope lines of the Trend Trader Index are drifting lower on a fast pace, indicating that the support/resistance levels for the S&P 500 are decreasing as well. In other words, as long as the market is not able to break through these strong resistance lines, we will see lower lows and lower highs, which is a typical pattern for a strong short-term down-trend. This can be also seen, if we focus on the Modified MACD which continued to show a widening bearish gap and has therefore refused to confirm the recent recovery from the S&P 500. Another strong non-confirmation is coming from the Advance-/Decline 20 Day Momentum Indicator, as its gauge is far away from being bullish. So from a pure short-term trend perspective, the recent recovery can be still categorized as a bounce rather than the beginning of a new sustainable up-trend.

More importantly, the current short-term oriented down-trend of the market is widely confirmed by our entire short-term oriented breadth indicators as we have not seen any major signs for a sustainable bottom yet! Especially, the percentage of stocks which are trading above their short-term oriented moving averages (20/50) dropped further into deep bearish territory, indicating an outright damaged trend-structure at the moment. To be more precise, only 14/17 percent of all NYSE listed stocks are trading above their 20/50 day simple moving average, the lowest numbers we have seen for months. Above all, we can see that the Modified McClellan Oscillator Daily and the Modified McClellan Volume Oscillator Daily remain in an outright bearish freefall. With such weak readings, it is quite unlikely that the recent bounce would lead to a sustainable trend-reversal! Another concerning fact is that the recent bounce on Friday was mostly driven by short-covering (which is not a big surprise as most traders wanted to log in their profits before the weekend), as we have only seen a strong reduction in the amount of stocks hitting a fresh new low, rather than a strong increase of those stocks which hit fresh new high. As a matter of fact, the High-/Low Index Daily remains outright bearish, although it slightly confirmed the rebound on Friday. Despite the fact that this can be seen as a quite encouraging sign, the overall signals within our breadth indicators remain too weak to call for a sustainable bottom at the moment.

As already mentioned in our previous market comment, a typical bottom tends to occur as a process rather than as a V-shaped recovery. If the market hits an important bottom, we usually see a strong counter trend rally, which normally lasts about 5 to 10 or even 20 trading sessions. After that, the market tends to show renewed strong weaknesses, which could then lead to a retest or even a break of its previous low. If this weakness comes along with more positive divergences within our market breadth indicators, we can be pretty sure that the market hits rock bottom; otherwise renewed waterfall declines can be expected (such a typical bottom building process occurred for instance in August 2015).

If we focus on our contrarian indicators, it looks like 1,815 within the S&P 500 represents such an important but intermediate low. This is mainly due to the fact that the drop towards 1,815 caused a washout among sentiment, whereas the amount of new lows spiked on that day. Moreover we can see that the bullish readings within our option based indicators remain persistent, indicating that the hedging activity among the crowd reached extreme levels (WallStreetCourier Index, WallStreetCourier Index Oscillator Weekly, OEX Call-/Put Ratio Oscillator Weekly, All CBOE Put-/Call Ratio Daily, ISEE Call-/Put Ratio Oscillator and the Market Timer Index). Above all, we can observe that also the Smart Money Flow Index showed some form of bullish divergence last week. Only the WSC Capitulation Index is still indicating a risk-off environment, which is pretty obvious if we consider the current price driven market circumstances. So all in all, the recent bounce could turn out to be a bit stronger in its nature; but given the outright bearish readings within our short-term breadth indicators, a break or at least a retest of the low around 1,815 looks quite likely at the moment.

Mid-Term Technical Condition

This view is also strongly confirmed by the current mid-term oriented condition of the market, as it has not shown any signs of bullish divergences yet. To be more precise, the gauge from the Global Futures Trend Index dropped again below its extremely bearish 20 percent threshold last week. As already mentioned in our previous market comments, as long as we do not see any stronger upside-momentum in the gauge of this reliable indicator or at least some bullish divergences, any upcoming gains will definitely be corrective nature rather than the start of a new sustainable uptrend. Consequently, a retest or even a break of 1,815 looks pretty likely for the time being. Moreover, we can say that the current correction cycle will be definitely not over as long as its gauge remains far below its bearish 60 percent threshold. On top of that we can see that the WSC Sector Momentum Indicator is far away from being bullish, although it did not drop as low as it did in August, where the S&P 500 reached similar levels. This might be another indication that 1,815 represents an important threshold to monitor. Anyhow, the bearish WSC Sector Momentum Indicator is telling us that the momentum score of most sectors within the S&P 500 are still underperforming the momentum score of riskless money market within our Sector Heat Map. In such a scenario, most sectors tend to perform negative on an absolute basis. This can be seen as another piece of evidence that it is a way too early to be a bargain hunter at the moment!

Basically, the same is true if we focus on mid-term oriented market breadth. To be more precise, the percentage of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (100/150) dropped towards new lows. This indicates that the recent bounce was not strong enough the get the broad market back on track! Consequently, there was no recovery within the broad market so far as most NYSE listed stocks remain in a strong mid-term oriented down-trend at the moment. This broad based non-confirmation can also be observed if we focus on the Advance-/Decline Index Weekly and on the Upside-/Downside Volume Index Weekly. Both indicators finished the week at quite bearish levels and therefore it is a way too early to bet on a sustainable trend-reversal for the time being. On top of that, we can see that the mid-term oriented tape momentum of the market also remains extremely short-biased as the Modified McClellan Oscillator Weekly continued to show a widening bearish gap last week. Apart from the fact that the readings from that indicator are far away from confirming the recent gains on Friday, it is also signaling that further selling pressure is ahead.

Long-Term Technical Condition

The long-term technical condition of the market remains unchanged. The Global Futures Long Term Trend Index is still indicating a technical bear-market for US equities, whereas the relative strength score of all risky markets keeps trading well below the one from US Treasuries. Furthermore, we can see that the global bear market is fully in force as only 8 percent of all global markets around the word remain in a long-term oriented up-trend. Despite the fact that the gauge from that reliable indicator has shown some strength recently, its absolute level is a way too weak to be taken too seriously at the moment. More importantly, this bearish long-term oriented trend is widely confirmed by long-term oriented market breadth. The percentage of all NYSE listed stocks which are trading above their mid-term oriented simple moving averages (200) dropped towards new lows, whereas the Modified McClellan Volume Oscillator Weekly and the High-/Low Index Weekly also strengthened their bearish signals last week!

Model Portfolios

Last week, there have been no changes within our model portfolios (WSC All Weather Portfolio, WSC Sector Rotation Strategy, WSC Inflation Proof Retirement Portfolio and the WSC Global Tactical ETF Portfolio).

Bottom Line

The overall strategic outlook remains almost unchanged compared to last week. In line with our recent call, the market is in the middle of a correction. Therefore conservative members should keep staying on the sideline as the current risk-/reward ratio is too low at the moment to act contrarian. This is mainly due to the fact that we have not seen any major positive signals/divergences within our indicator framework yet to call for an important bottom at the moment. Consequently, it might be just a question of time until renewed weaknesses towards 1,815 or even below can be expected. Nevertheless, from a pure contrarian point of view a (limited but stronger) continuation of the recent rebound looks quite likely. As a matter of fact, aggressive traders should close their profitable short-positions if the market closes above 1,920 as further strength towards 1,950 and worst case even towards 1,987 could be likely. Afterwards, they can re-open them again if the market drops back below 1,950. On the other hand a break below 1,867 would call for further down-testing towards 1,845/1,815 and then 1,780/1,741.

Stay tuned!